This Fed Meeting Is About Talk, Not Action

DailyFX

This Fed Meeting Is About Talk, Not Action

The US dollar (USD) extended its losses against the euro (EUR), British pound (GBP), and Japanese yen (JPY) ahead of today's interest rate decision from the Federal Reserve. The Fed is widely expected to leave monetary policy unchanged, especially after this morning's economic reports. We have seen persistent deterioration in US data that will make it extremely difficult for policymakers to justify the need to taper asset purchases.

This morning's ADP number raises concerns about how much the labor market improved in April after the big deterioration in March. While the Fed is still waiting for Friday’s non-farm payrolls (NFP) report, there's a very good chance that the tone of the Federal Open Market Committee (FOMC) statement could be slightly more cautious, which could put more pressure on the greenback.

According to ADP, private payrolls dropped from 131K in March to 119K in April. The ISM manufacturing index also fell to its lowest level this year. At 50.7, and down from 51.3, manufacturing activity in the US is barely expanding. While this pullback in activity is not a significant surprise because regional indices have fallen as well, it confirms that the pace of the US economic recovery is far from desirable.

Behind closed doors, we expect the hawks inside the Fed to back off and the doves to sing louder about the need to maintain the current level of stimulus, but none of these discussions are likely to appear in the FOMC statement. Instead, we expect the statement to remain mostly unchanged because the conclusions of the Beige Book suggest that the weakness in March did not extend into April.

Still, given the sharp decline in the ISM and ADP reports, it may be difficult for Fed officials to believe the Beige Book entirely, especially without seeing Friday's NFP report.

Conflicting signals from US data will only widen the diverging views within the central bank, forcing the Fed to hold monetary policy steady until September, or more likely, December. We are eager to see if the central bank changes its assessment of the labor market, possibly becoming more mixed after citing "signs of improvement" last time.

It will also be interesting to see whether Fed policymakers acknowledge the recent softening in economic data. If they do, it could drive the US dollar lower as well.

By Kathy Lien of BK Asset Management

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